UNITED NATIONS, July 9 (Reuters) - The U.N. Security Council warned Eritrea on Thursday it would consider action against anyone undermining peace in Somalia, in a threat of possible sanctions on Asmara for alleged support to rebels.

The warning, in a formal statement, followed an appeal by African Union leaders last week to the 15-nation council to impose sanctions on Eritrea, which the AU said was aiding Islamist insurgents fighting Somali government forces.

Noting that request, the British-drafted statement said the council was "deeply concerned in this regard and will consider expeditiously what action to take against any party undermining the ... peace process" in the Horn of Africa state.

Somalia's government and others have accused Eritrea of supplying arms to the insurgents in breach of a U.N. embargo that allows such shipments only to the government. Diplomats said any sanctions would be considered after a U.N. group monitoring the embargo reports back later this month.

Al Qaeda-linked fighters belonging to the al Shabaab insurgent group control much of southern and central Somalia and most of the capital Mogadishu. Last week over 70 people were killed as government troops tried to drive back insurgents who have been advancing on government position in Mogadishu.

The top U.N. political official, Lynn Pascoe, told a council debate it was "a critical time for Somalia," where 1.3 million people are internally displaced.

"The choice before us is a stark one," Pascoe said. "Either we help the Somali people overcome the current attempt to thwart efforts towards peace, or we allow the new unity government ... to fall to a radical armed opposition."

Eritrean officials deny the charges of arms supplies. "We haven't given any weapons to Somali insurgents, or to the government for that matter," the Red Sea state's U.N. envoy told Reuters. "They don't have any evidence at all."

ERITREA BLAMES ETHIOPIA

"They want to corner us by putting sanctions, which is totally ridiculous," Ambassador Araya Desta said. He called the allegations a "fabrication" by Eritrea's rival Ethiopia.

But U.S. Ambassador Susan Rice told the council Washington was "particularly concerned about the financial, military, logistical and political support that the government of Eritrea is offering to al Shabaab and other extremists."

Rice said the Eritreans had rebuffed repeated U.S. attempts to discuss the issue. "But even now it's not too late. The United States calls on the government of Eritrea to seize this window of opportunity to change course," she said.

French Ambassador Jean-Maurice Ripert also noted the insurgents were reportedly receiving arms from Asmara and said France was prepared to undertake sanctions against those blocking peace.

Pascoe and Security Council envoys urged U.N. member states to fulfill pledges of support for Somalia's interim government and for a 4,300-strong AU force that backs it. A donors' conference in Brussels pledged over $200 million in April.

Rice told the council that despite a strong international response to piracy off Somalia's coast, more countries needed to take responsibility for prosecuting captured pirates.

Condemning the widespread practice of paying ransoms to pirates to win the release of hijacked cargo ships, Rice also proposed creation of a group of "no concession" states to work together to slow the rise of piracy. (Editing by Bill Trott).